MIAMI-Index funds beating active managers and mutual fund costs rising are just two of numerous misconceptions about the industry that Paul G. Haaga, Jr., vice chairman of Capital Research and Management, addressed last week in his "Revisiting Conventional Wisdom About Mutual Funds" keynote speech at The National Investment Company Service Association's 25th Anniversary Annual Conference & Expo here.

There are many critics of the industry, and "we all need critics, but it is only useful when we do not blindly accept what they say," Haaga said.

"Most myths are neither entirely right nor wrong," he said. A lot of times, statistics held up against the industry are misleading but are broadly accepted and result in a closing of the minds, he said.

The first myth is the belief that index funds, specifically those tied to the S&P 500, always beat active managers. "Not everyone always wants to beat the S&P, and people are under the assumption that we are in an underlying punitive horse race," he said.

Active managers don't always lose out, he said. In fact, they tend to deliver more consistent returns than index funds, he added.

Another misconception is that mutual fund costs are rising. Haaga gave the example of a town of 100 people all driving a $20,000 car but one person buying a $500,000 Bugatti, pushing the average cost of cars owned in the town to $260,000 even though the price of the cars owned by the 99 others hadn't risen.

Relating to the industry, in the 1980s and 1990s, the industry started offering exotic funds that a minority chose to invest in, but that raised the industry's average fees. "We sat back and let people tell us we were raising costs," Haaga said.

There is also a myth that mutual fund shareholders do not achieve the same performance as funds, he continued. "Lots of times, it's just that shareholders get out of funds at the wrong time," he noted. The industry should focus on the behavior of investors and deemphasize recent performance, as it reiterates the need for advisers.

Advisers can help guide investors not to pour all their money into hot funds, or take their money out when the market is down. "They can manage people's expectations," he said.

Oftentimes, the industry does not recognize the importance of independent directors, Haaga said. "They do have a huge impact, and my rule is that we always talk about an issue twice with our directors," he said.

Directors can act as a sounding board to management, pointing out shortcomings and suggesting ways to improve them, he said.

However, companies are not "thinking up heinous things to do and waiting for our directors to swat us down," he said.

The best use of independent directors, Haaga suggested, is to engage them in conversation and not isolate them. "When you stop telling them what to do and when to breathe in and out, they will perform brilliantly for shareholders," he said.

Although Haaga said he is against getting rid of the independent director role, he does not believe fund boards need to be overseen by an independent chairman or governed by as many as 75% independent directors.

Many people think the mutual fund industry is riddled with conflicts of interest, but, again, this is not the case, Haaga maintained. "Why is self interest a conflict of interest?" he asked.

Another myth is that competitors are "eating our lunch, and eventually there will be no more mutual funds," he said. "Exchange-traded funds and hedge funds are eating our lunch this year, and the year before that, it was separately managed accounts and hedge funds-of-funds. It is always something," he noted.

"We need to ask ourselves, Why is the competition beating us?'" he said.

Discussing the competition and learning from it is important, but mutual funds are not going to become obsolete, he said. The industry is thriving, with 50% of Americans owning mutual funds and 400 fund companies offering more than 8,000 funds, he noted.

Yet another myth, Haaga said, is that large funds underperform. Critics have yet to present a study that proves this, he said.

Haaga noted that ethical standards are very important to the success of the industry, and "discussing them is the best reminder that we need to continue to live them everyday," he said.

Regarding challenges, Haaga noted that regulatory issues will always exist. "We need to identify everything we do before the regulators ask us to, and we need to remember there will be occasional police riots," he said.

(c) 2007 Money Management Executive and SourceMedia, Inc. All Rights Reserved.

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